Business context and reporting period
Hawaiian Electric Industries, Inc. (HEI) filed this unaudited combined Form 10-Q with its wholly owned electric utility subsidiary, Hawaiian Electric Company, Inc. The report covers the quarter and nine months ended September 30, 2015, compared with the corresponding 2014 periods. HEI’s businesses include electric utilities and American Savings Bank (ASB).
Financial performance and position
- HEI, third quarter: Revenue was $717.2 million, down 17% year over year, while operating income rose 5% to $97.1 million and net income attributable to common stock rose 6% to $50.7 million. Basic EPS was $0.47, unchanged; higher weighted-average shares offset increased earnings. Consolidated operating margin, calculated from reported figures, was approximately 13.5%, versus 10.6%.
- HEI, first nine months: Revenue was $1.979 billion, down 19%; operating income declined 9% to $239.3 million; common net income fell 13% to $117.6 million; and basic EPS declined 17% to $1.11. Consolidated operating margin was approximately 12.1%, versus 10.8%. The decline in revenue largely reflected lower utility fuel and purchased-power costs, while lower utility earnings and higher corporate costs weighed on profit.
- Electric utilities: Third-quarter revenue fell to $648.1 million from $803.6 million, largely due to lower fuel prices and purchased-power costs. Operating income increased to $82.7 million from $76.2 million, and common-stock net income increased to $43.0 million from $38.9 million. For nine months, revenue fell to $1.780 billion from $2.262 billion; operating income decreased to $206.5 million from $216.9 million; and common-stock net income fell to $102.7 million from $108.5 million. Utility operating margin was approximately 12.8% for the quarter and 11.6% year to date, compared with 9.5% and 9.6%, respectively, in 2014.
- ASB: Third-quarter net income was $13.5 million, up slightly; nine-month net income was $39.8 million, versus $39.2 million. Nine-month net interest income increased to $139.9 million from $133.8 million, but net interest margin narrowed to 3.52% from 3.60%. The nine-month loan-loss provision rose to $5.4 million from $3.6 million, and annualized net charge-offs increased to 0.08% from 0.01%.
- Cash flow: HEI generated $221.3 million of operating cash in the first nine months, used $503.0 million in investing activities, and received $334.6 million from financing activities. Hawaiian Electric generated $201.6 million of operating cash, used $230.1 million in investing activities, including $265.5 million of capital expenditures partly offset by construction contributions, and generated $25.5 million from financing activities.
- Debt and liquidity: At September 30, HEI reported $228.4 million of cash and cash equivalents, $172.0 million of short-term borrowings other than bank borrowings, and $1.507 billion of long-term debt other than bank borrowings. Hawaiian Electric reported $10.7 million of cash, $95.0 million of short-term borrowings from non-affiliates, and $1.207 billion of long-term debt. ASB had $4.826 billion of deposits and $368.6 million of other bank borrowings. ASB reported $1.7 billion of unused FHLB borrowing capacity and was well-capitalized, with a 12.2% common equity Tier 1 ratio.
- Dividends and equity: HEI paid $0.93 per common share in dividends during the first nine months. It issued shares through settlement of its equity forward transaction, receiving $104.5 million net in March 2015.
Material changes versus the prior comparable period
- Lower fuel prices and purchased-power costs substantially reduced utility revenue and expenses. Despite higher third-quarter utility earnings, year-to-date utility operating income and common net income were lower.
- HEI’s year-to-date earnings decline also reflected higher corporate “other” losses: the nine-month net loss was $24.9 million, versus $12.8 million in 2014, primarily due to merger- and spin-off-related costs.
- ASB’s loan portfolio, deposits, and investment securities grew. Higher earning-asset balances supported interest income, while the low-rate environment pressured asset yields and net interest margin.
- The company revised its previously filed 2014 nine-month cash-flow presentation for identified classification and control issues. Management said the revisions were not material and did not change previously reported net changes in cash or the balance sheets or income statements.
Outlook, commentary, risks and unusual items
- Proposed NEE merger and ASB spin-off: HEI shareholders approved the merger in June 2015; the FERC authorized it and the HSR waiting period expired. Hawaii PUC approval and other conditions remained outstanding. PUC hearings were scheduled for November 30–December 16, 2015. The agreement contemplated 0.2413 NEE shares per HEI share, a distribution of ASB Hawaii shares, and a $0.50-per-share special dividend, all subject to closing conditions. Merger-related shareholder litigation was pending; the companies said they considered the claims without merit.
- Utility outlook: Management expected 2015 utility kilowatt-hour sales to decline below 2014 levels, reflecting customer solar generation and energy efficiency. It projected 2015 utility O&M expense to be flat versus 2014, revising its prior expected decrease after, among other items, a $4.8 million ERP software write-off. Forecast 2015 net capital expenditures were reduced to approximately $310 million from $420 million; Hawaiian Electric said it would not need an HEI equity infusion in 2015.
- Regulatory and energy transition: The PUC’s changes to the rate adjustment mechanism and review of utility power-supply plans create uncertainty around cost recovery and returns. Utilities are pursuing renewable generation, grid modernization, and LNG options; LNG plans face regulatory and political uncertainty. Management cited a 90–110 basis-point expected structural gap between actual and allowed utility returns in 2015–2016.
- Operations and environmental matters: The utilities were preparing to meet Mercury and Air Toxics Standards by April 2016, although litigation over the rule continued. Environmental investigations include PCB-related matters at Pearl Harbor and the former Molokai generation site; the latter had a $3.6 million reserve, while ultimate remediation costs for the Pearl Harbor matter were undetermined. The utilities also faced potential Clean Air Act enforcement costs that management could not estimate.
- Bank and market risks: ASB is exposed to interest-rate movements, deposit competition, credit losses, and Hawaii real-estate concentration. Nonaccrual loans increased to $45.4 million from $36.9 million at year-end 2014. HEI and Hawaiian Electric both had negative Moody’s outlooks, attributed to execution risk in transforming oil-based generation to renewables.
- Controls: Both HEI and Hawaiian Electric reported ineffective disclosure controls as of September 30, 2015 because of a material weakness in controls over preparation and review of cash-flow statements. Management was implementing remediation, but had not yet demonstrated that new controls operated effectively for a sufficient period.
- HEI dividend outlook: HEI said it currently expected to maintain its dividend at the then-current level, subject to quarterly board review and business and economic conditions.
Most important facts for investors to verify
- Whether the NEE merger and ASB spin-off received all required approvals, and whether litigation or other conditions affected closing or the proposed consideration.
- Whether utility rate mechanisms and PUC decisions permit timely recovery of capital, operating, environmental, and energy-transition costs—and how returns compare with allowed levels.
- Whether utility sales, O&M costs, and capital expenditures tracked management’s stated outlook, including the revised $310 million capital-spending forecast.
- Whether ASB’s credit quality, net interest margin, funding mix, and capital ratios remained resilient as loans and deposits grew.
- Whether HEI and Hawaiian Electric remediated the cash-flow control material weakness and established effective controls; also monitor the disclosed environmental and regulatory contingencies as cost estimates develop.